This is a money grab with the polish of a pro-gamer cheat-cleanup. Why do I say that? Microsoft can fix most of the 'cheats' that a software controller can implement in software. Auto-fire is trivial to detect, as is a KBM setup where it doesn't belong. Out of the ordinary joystick characteristics/speed/hysteresis/range would make it obvious to them which controllers are aftermarket if they cared to disallow them aft…
OK, maybe I'm biased here as a PC gamer who frequently uses a controller... but why not just allow both? Some games like Gears of War on Xbox already do this. Others, like Fortnite, offer crossplay and just show a symbol over each player's head. Do mouse and keyboard players have an advantage? Sure. So do players with bigger TVs or Series X graphics or less worn controllers or the Elite controller. Big deal? The PC e…
Failing to do so creates a pay-to-win situation.
Now, you might be thinking, companies obviously have no problem with a pay-to-win situation. But you see, there is a critical difference; the companies want you to pay them to win. Paying a third-party, unapproved, unlicensed hardware manufacturer results in $0 dollars going to Microsoft for your pay-to-win experience, and that is just unacceptable.
That's the first-order answer. There's a second-order answer too, which is that even in a pay-to-win situation the company still needs enough control to put up a competent and plausible cover over the pay-to-win mechanics; imagine a game that is literally pay to win, that is, the only input to the "game" (such as it is) is literally how much you paid for it. This obviously wouldn't last long, the best they could hope for is a income trajectory that looks like the I Am Rich app [1], and with even modest cleverness a company can milk a pay-to-win situation much longer than that. And on this level too, there's a problem for Microsoft. The pay-to-win situation is extremely poorly tuned for retention of either the payers or the non-payers; the hardware maxes out the winningness pretty quickly for not much money and doesn't give Microsoft any opportunity to manipulate the non-payer's experience, creating a very hostile environment for players giving Microsoft more money.
You can add more detail to the model in a third-order analysis that considers the player's reactions to the manipulations of the software companies to avoid the negative effects of a simplistic pay-to-win model and the player reactions to the cheaters, and start modeling changes-over-time more explicitly, and it's not hard to see how having pay-to-win cheaters out of the control of Microsoft causes both Microsoft and the non-cheating players a lot of problems too.
I'll leave that as an exercise to the reader, but I will give you the hint that if you draw it out far enough it becomes clear that it's actually a very difficult situation in the limit. As others mention, the hardware hackers can just move up a layer in the stack and resume their work. You'll discover this is not a place where there's a "solution", but that it's intrinsically an arms race, which is why this problem still hasn't been "solved", in either direction by the cheaters or the game devs, even after decades of work by both of them.
(The software fixes proposed elsewhere are not a solution, only another step in the arms race. A good step, and possibly a step worth taking, but only a step. It does at least pull down the skill ceiling you can buy access to, to the point a human might at least hope to stand a chance, but the risk of blocking a top-end player, which is also a player than can cause a PR stink on YouTube, rises steadily as you ratchet down the detection threshold.)